sources of capital in russia

8/2/2019 Sources of Capital in Russia

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In accordance with US SEC Regulation AC, analyst certification can be found on the last page of this report.

[email protected], www.troika.ru

RUSSIA | STRATEGY

DECEMBER 2010

End sources of financial capital inRussia, $ bln

0

150

300450

600

750

D e p o s i t s

S y n d i c a t e d

d e b t

F o r e i g n

e q u i t y

F o r e i g n

b o n d

P e n s i o n

f u n d s

R e t a i l

h o l d i n g s

M u t u a l

f u n d s

I n s u r a n c e

s e c t o r

Source: Central Bank, Lionshares, Cbonds, Investfunds.ru,Troika estimates for 3Q10

Increase in domestic capital, $ bln

0

30

60

90

120

Deposits State pension

fund

Private

pension fund

Mutual funds Insurance

funds

Growth in 2010 Growth in 2011 Source: Central Bank, Investfunds,ru, Troika estimates

Equity market ownership

30%

29%

15%

14%

6%6%

Free float

Government

Oligarch

ManagementOther company

Foreigners

Source: Companies, Troika estimates

Capital raising in Russia, $ bln

0

50

100

150

200

250

2005 2006 2007 2008 2009 2010 2011 2012 2013

Loc al d eb t Forei gn d eb t T ot al equit y Source: Cbonds, Central Bank, Dealogic, Troika estimates

Kingsmill Bond, CFA +44 (207) 822 0771

[email protected]

Andrey Kuznetsov +7 (495) 933 9844

[email protected]

Sources of Capital in RussiaShow Me the MoneyWe summarize assets and liabilities for households, companies, the

government, banks, institutions and foreigners, and examine the nature

of the debt and equity markets to identify unusual aspects of the Russian

capital markets.

█ Foreigners are the key source of longterm capital. Foreign investors are

the providers of financial capital for the equity (75%), Eurobond (70%) and

syndicated loan (100%) markets, and provide 44% of the total financial

capital in Russia. Foreign perception is therefore arguably as important for the

equity market as local reality.

█ The principal source of domestic capital is deposits. Deposits make up82% of identifiable domestic financial capital, and are intermediated by the

banks into domestic loans, with little available for longterm investment.

█ Russia has limited institutional capital. The total size of the Russian

pension system is 3% of GDP, mutual funds are 1%, and insurance funds are

1%, a fraction of what we see in Eastern Europe. If Moscow is to develop as a

financial center, it will be necessary to stimulate the growth of this capital, a

financial deepening process we have seen elsewhere.

█ Corporate debt is already high. Given the lack of depth elsewhere in the

markets, investors should be relatively cautious about corporate debt, which

amounts to 48% of GDP.

█ Foreigners will be key to new capital provision. As most deposits are

recycled by the banks into loans, and institutional capital growth is low,

foreigners will be the principal source of capital for the coming wave of debt

and equity issuance. As the current account is shrinking, and debt capital is

not so easy to attract as before, this should lead to better corporate

governance and higher rates.

█ Beware the money illusion. In theory the government, the oligarchs and

homeowners control assets with tremendous value. However, the lack of

domestic capital means that valuations are suspect, and these assets cannotbe realized easily. Investors should thus avoid capital raisings that are not

accompanied by very clear standards of corporate governance.

█ Who owns the equity market? Of the free float of around $250 bln, we can

identify $120 bln in assets held by foreign longonly funds, but only $4 bln held

by Russian mutual funds, $19 bln by the banks, $10 bln by pension funds, and

perhaps $25 bln by retail. The rest is held by oligarchs or hedge funds.

█ Where is household wealth? We calculate that 84% of household wealth is

in property, 12% in deposits, and just 4% in all other financial assets.



DECEMBER 2010 SOURCES OF CAPITAL IN RUSSIA – SHOW ME THE MONEY

2 TROIKA DIALOG

PAGE INTENTIONALLY LEFT BLANK



SOURCES OF CAPITAL IN RUSSIA – SHOW ME THE MONEY DECEMBER 2010

TROIKA DIALOG 3

Contents

Assets and Liabilities of Key Players..................................................................................................4 Households.................................................................................................................................4 Corporates..................................................................................................................................6 Government ............................................................................................................................... 7 Banks..........................................................................................................................................7 Oligarchs .................................................................................................................................... 8 Foreign capital ............................................................................................................................ 9 Pension system .........................................................................................................................10 Mutual funds ............................................................................................................................10 Insurance..................................................................................................................................10 Summary ..................................................................................................................................11 Growth in domestic capital .......................................................................................................11 Liabilities...................................................................................................................................14

Capital Markets..............................................................................................................................15 Summary ..................................................................................................................................15 Equity market ...........................................................................................................................15 Government bond market.........................................................................................................18 Corporate bond market ............................................................................................................19 Bank bond market ....................................................................................................................19

Capital Raising Plans ......................................................................................................................20 What is planned? ......................................................................................................................20 How feasible are these plans?...................................................................................................20 Russia as a financial center........................................................................................................21

Appendix 1: How Russia’s Pension System Works..........................................................................22 The payasyougo system .......................................................................................................22 Savings part: government linked...............................................................................................23 Savings part: private .................................................................................................................24

Appendix 2: Russian Capital Flows .................................................................................................25




4 TROIKA DIALOG

Assets and Liabilities of Key Players

We set out below a summary of where we are able to identify financial assets and liabilities in the

Russian market. Although the best comparable markets lie in BRIC or Eastern Europe, we

benchmark against the US, as this has good data, and we bring in other points of comparison where

available.

It is clear that there will always be double counting involved in any analysis of financial assets and

liabilities, and we have concluded, following the methodology of the US Federal Reserve, that it is

impossible to net this out. Rather, we look at each piece separately, and then seek to add up the

totals insofar as it makes sense to do so.

We look therefore at households, corporates, the banks, the government, foreigners and oligarchs,

and then at the main areas of institutional money – pensions, mutual funds and insurance companies.

We then seek to summarize the nature of assets and liabilities, and where growth can be expected.

Households

ASSETS

The gross financial assets of households in Russia make up 26% of GDP compared with 279% in

the US. The only area in which Russian households have comparable financial assets is in deposits,

while all other longterm capital is tiny.

Household assets/GDP

0%

15%

30%

45%

60%

75%

Deposits Bonds Equities Mutual

funds

Insurance Private

pensions

Government

pensions

US Russia

Source: Central Bank, Rosstrakhnadzor, State Statistics Service, US Federal Reserve, Troika

estimates

LIABILITIES

Equally, Russian household liabilities are relatively limited.




TROIKA DIALOG 5

Household liabilities/GDP

0%

20%

40%

60%

80%

Mortgages Other mortgage Consumer credit Other

US Russia

Source: Central Bank, US Federal Reserve, Troika estimates

NET FINANCIAL ASSETS

And on a net basis, the US household sector is still well ahead of its Russian counterpart. The US

household sector’s net financial assets are 147% of GDP, compared with just 18% in Russia.

HOUSING

The last issue to consider is housing, where the data is not perfect. According to Freddie Mac, the

total value of US housing stock is $17 trln, or some 117% of GDP, and a little lower than net

financial assets. It is worth noting that this implies a value per m2 of housing of under $1,000/m2

for the 20 bln m2 of US housing.

Data from Russia’s State Statistics Service on the value of Russian housing is mixed. The total

amount of housing is 3.2 bln m2; the average secondary market price is $2,000/m2 (nearly twice

the level of the US); and the total value is thus, in theory, over $6 trln, or four times the level of

Russian GDP. However, one comes to the inevitable conclusion that the values in the secondary

market are not a fair reflection of reality. If we assume that 20% of the housing has no value, and

then ascribe a value of $4,000/m2 to Moscow housing and $500/m2 to the rest of the country,

then the total value of the housing stock is around $2 bln, with an implied value of $800/m2. This

gives a value as a percentage of GDP of 132%, higher than in the US.

Given that on the whole we believe Russian housing is not of such a high standard as in the US, this

is a somewhat counterintuitive conclusion, and we do not set too much store by it. However, it is

interesting only insofar as it shows that in Russia housing is relatively expensive, and the main

source of household wealth is property, making up 84% of the total. The reason for this is pretty

clear – for the vast majority of people, housing, and not financial assets, has been able to hold value

over the course of the last 20 tumultuous years; money therefore shifts into housing. The other

reason is the fact that few people had to buy their own houses, so the market is very thin. However,

as Russia increases its transparency, as people are able to build more homes and as other

investment opportunities open up, it seems likely that the real price of houses should fall over time.




6 TROIKA DIALOG

Household sector net wealth, % of GDP

0%

50%

100%

150%

200%

250%

300%

US Russia

Net financial Housing

Source: Central Bank, State Statistics Service, US Federal Reserve, Freddie Mac, Troika estimates

Corporates

ASSETS

We do not have comprehensive data on corporate assets, but do know some part of what they

have: deposits are $330 bln, or 21% of GDP, which is higher than in the US, where corporate

deposits are only 17% of GDP. We believe that the main reason for this is the lack of alternative

opportunities for corporates to put their capital to work.

LIABILITIES

Russian corporates are surprisingly highly indebted, with some $725 bln in debt. The majority of

this is to Russian banks, with another large amount in syndicated debt to Western banks.

Corporate debt in Russia, $ bln

0

100

200

300

400

500

Bank debt Dollar syndicate Dollar bonds Ruble bonds

Source: State Statistics Service, Cbonds, Central Bank

US corporate debt as a percentage of GDP is only twice the level of Russia, which gives us some

cause for concern given how much smaller most Russian financial instruments are. Most interesting

is the fact that in Russia the domestic bond market for corporates is tiny, meaning that corporations

are obliged to borrow disproportionately from banks and foreigners.




TROIKA DIALOG 7

Corporate debt/GDP

0%

20%

40%

60%

80%

100%

120%

US Russia

Domestic bond market Domestic bank loansForeign bank loans and bonds

Source: State Statistics Service, Cbonds, Central Bank, US Federal Reserve

Government

ASSETS

The Russian government has assets of $500 bln, held mainly in foreign bonds, with a value of

around 33% of GDP.

In addition, the government owns $298 bln in listed equity market assets, according to our

calculations, or some 20% of GDP. This is also surprisingly high. While the two are not strictly

comparable, the Federal Reserve data from the US on equity ownership by the government shows

this to be around $200 bln, just 1% of GDP, and less even in total than in Russia.

LIABILITIES

Liabilities are low at just 10% of GDP in Russia, versus well over 100% in the US.

Government debt/GDP

0%

30%

60%

90%

120%

150%

US Russia

Bonds Government agencies/ banks

Source: US Federal Reserve, Central Bank

Banks

ASSETS

Russian banks have $1 trln in assets, or 70% of GDP. This is comparable with the US, where

commercial banks have assets equal to 100% of GDP. The reason why the two are comparable in

size in spite of the smaller amount of assets in Russia is that in the US, there are many alternatives to

banks, but in Russia (as in many other emerging markets) the banking sector acts as the key

financial intermediary to the economy. In Russia, there are far fewer consumer loans than in the US,

and the corporate sector is disproportionately important.




8 TROIKA DIALOG

Bank assets/GDP

0%

20%

40%

60%

80%

100%

US Russia

Consumer loans and mortgages OtherCorporate loans Cash and reserves


LIABILITIES

Both banking systems are largely funded by deposits. The Russian banks have a far smaller share ofbonds outstanding, however, as well as a relatively large amount of syndicated debt, which we

estimate at $95 bln.

Bank liabilities/GDP

0%

20%

40%

60%

80%

100%

US Russia

Deposits Other Bonds Government


Oligarchs

We do not have detailed data on the assets and liabilities of the Russian oligarchs. However, we do

have some inferred numbers.

ASSETS

We calculate that oligarchs and management teams own $299 bln in equity in declared stakes in

listed Russian corporates, as well as around $73 bln in what we assume to be closely held stakes.

This is a total of 25% of GDP, which is relatively large, being more than four times the size of the

total institutional money. However, because of the lack of institutional money, these stakes are hard

to monetize, and we believe that this gives rise to an interesting conundrum: Russian oligarchs have

enormous paper wealth, but that wealth is dependent on relatively small free floats of shares largely

owned by foreigners. So, it should be in their interest to ensure that foreign minority investors are

well treated and that dividend streams are high. However, minority shareholders are for the most

part not especially well treated, and dividends are low. It is this dynamic that makes the Russian

market so volatile and dependent on foreign perception, and that drove it to such low levels in thedark days of 200809.




TROIKA DIALOG 9

LIABILITIES

As we found to our cost in the crisis of 2008, we are unable to measure the level of oligarchs’ debts.

However, we believe that some of this is captured in the data on Russian corporate debt, which is

higher than what is implied by our bottomup company analysis.

Foreign capital

EQUITY MARKET ASSETS

There is remarkably good data on the amount of foreign capital in the equity market. Lionshares tracks

$120 bln of foreign equity assets in Russia, by far the largest single source of assets in the market. We

estimate that foreign investors own around three quarters of the total real free float.

DEBT MARKET ASSETS

We estimate that foreigners own $20 bln of ruble debt, some 13% of the market, as well as $97 bln

of hard currency debt, some 70% of the market, and almost all of the $291 bln in syndicated debt (toboth corporates and banks). There is a separate question, of course, as to how much of this foreign

money is in fact Russian investors recycling their money back into the market, but this issue is beyond

the scope of this report.

Foreign investor financial claims on Russia, $ bln

0

50

100

150

200

250

300

Syndicated

loans

Long only

fund equity

Dollartraded

debt

Hedge fund

equity

Ruble debt

Source: Cbonds, Central Bank, Lionshares, Troika estimates

BENCHMARKED TO US

Foreigners therefore own 39% of Russia’s total GDP through syndicated debt, traded debt and

equity. While this is lower than in the US, it is a much larger share of the total amount of capital

available as a result of the lack of domestic capital.

Foreign ownership of debt and equity, % of GDP

0%

20%

40%

60%

80%

US Russia

Equity Debt

Source: Federal Reserve, Central Bank, Cbonds, Troika estimates




10 TROIKA DIALOG

Pension system

SIZE

The Russian pension system has a total of $48 bln in assets, half in the government fund, VEB,$4 bln in managed government funds and $20 bln in private funds. This is a total of just 3% of GDP.

This is very small in the global context. The US pension system has 52% of GDP in private schemes

and 28% in public schemes. Moreover, there are some markets like Chile, where assets in the

pension system are as high as 65% of GDP. It is nevertheless worth noting that there are other

markets like Germany or France which have yet to grasp the nettle of moving from a pay as you go

system, and which also have very small amounts of longterm pension assets.

Pension assets/GDP, 2009

0%

15%

30%

45%

60%

75%

C h i l e

S o u t h A f r i c a

U S

M a l a y s i a

B r a z i l

P o l a n d

G e r m a n y

I n d i a

R u s s i a

T u r k e y

Source: Towers Watson, OECD

Mutual funds

Data from investfunds.ru imply that the total size of the Russian mutual fund industry is no more

than $14 bln, less than 1% of GDP. Of this, $3 bln is in openended PIF funds (the main source of

pooled equity investment) and $7 bln is in property funds, which are often used as a vehicle for

private property investment.

Size of Russian mutual funds, $ bln

0

2

4

6

8

Property Equity Debt Other

Source: Investfunds.ru. Troika estimates

In contrast, the US has mutual fund assets of 66% of GDP, in Poland it is 8% of GDP, and many

other markets have mutual funds of well over 10% of GDP.

InsuranceAccording to the insurance regulator, the insurance sector runs $12 bln of funds, less than 1% of

GDP. Of these, just $2 bln are in equities, In contrast, the US system has 34% of GDP.




TROIKA DIALOG 11

Summary

We summarize below the various different sources of capital in total.

Total sources of assets/GDP

C o m m e r c i a l b a n k s

F o r e i g n e r s

M u t u a l f u n d s

H o u s e h o l d d e p o s i t s

P r i v a t e p e n s i o n f u n d s

H o u s e h o l d e q u i t y

I n s u r a n c e f u n d s

S t a t e p e n s i o n f u n d s

C o r p o r a t e d e p o s i t s

G o v e r n m e n t

O l i g a r c h s / m a n a g e m e n t

0%

20%

40%

60%

80%

100%

US Russia

Source: Central Bank, US Federal Reserve

However, there is a large amount of double counting here. For example, the majority of the liabilities

of the commercial banks are deposits, and arguably the oligarch and government money is hard to

realize. So, if we look simply at the end sources of liquid financial capital, the picture emerges as

below, dominated by deposits and foreign capital.

End sources of capital in Russia, 3Q10

0

150

300

450

600

750

D e p o s i t s

S y n d i c a t e d

d e b t

F o r e i g n

e q u i t y

F o r e i g n

b o n d

h o l d i n g s

P e n s i o n

f u n d s

R e t a i l

h o l d i n g s

o f e q u i t y

M u t u a l

f u n d s

I n s u r a n c e

s e c t o r

Source: Central Bank, Lionshares, Cbonds, Investfunds.ru, Troika estimates

Growth in domestic capital

There are two main factors driving domestic liquid capital formation in Russia: the speed at which

deposits grow and the amount of capital that is invested in places other than deposits. We believe

that the main driver will continue to be deposits.




12 TROIKA DIALOG

Increase in domestic capital, $ bln

0

30

60

90

120

Deposits State pension

fund

Private

pension fund

Mutual funds Insurance

funds

Growth in 2010 Growth in 2011

Source: Central Bank, Investfunds,ru, Troika estimates

DEPOSIT GROWTH

Before the crisis, deposits were linked to M2, and M2 was simply a function of the increase in forexreserves, which in turn was the consequence of Russia’s large current account and capital account

surplus. As the government built up its foreign reserves, so M2 grew, and so the size of the banking

sector swelled.

Russian gross international reserves and M2, $ bln

0

200

400

600

800

2005 2006 2007 2008 2009 2010 2011

Gross international reserves M2

Source: Central Bank, Troika estimates

Domestic deposits and M2, $ bln

0

150

300

450

600

750

2000 2002 2004 2006 2008 2010

M2 Deposits

Source: Central Bank

Since the crisis, the government has largely allowed the ruble to float, and the driver for M2 growth

has been the fiscal deficit, as well as nominal GDP growth. We expect M2 to grow at around 25% in

2011 in ruble terms as a result of these factors and as the monetization of the Russian economy

moves closer to that of Eastern Europe. We expect deposit growth of a little less than this, driven by

household savings and corporate cash f low generation.

East European M2/GDP

0%

20%

40%

60%

80%

Russia Latvia Ukraine Poland Hungary Bulgaria CzechRepublic

Source: IMF

Russian M2/GDP

0%

10%

20%

30%

40%

50%

1995 1997 1999 2001 2003 2005 2007 2009





TROIKA DIALOG 13

PENSION FUNDS

Pension funds have been growing quite fast from a low base, to reach some 3% of GDP; the

widespread belief is that they will continue to increase in the same way as we have seen in Poland,

where they are now 16% of GDP.

Size of Russian pension funds, $ bln

0

5

10

15

20

25

30

2002 2003 2004 2005 2006 2007 2008 2009 2010

State Private

Source: Investfunds.ru

However, as we detail in the appendix, the current plan is to curtail the shift of capital into the state

fund, leaving only private capital as the driver of growth. Unless there is legislation to encourage this

further, we do not believe that it is likely to exceed $4 bln a year, which is a relatively small amount.

MUTUAL FUNDS

The experience of Poland, where mutual funds have risen to some 8% of GDP, once more indicates

that there is tremendous potential for growth if people could be persuaded to invest their money

accordingly. However, total mutual funds in Russia are still less than 1% of GDP, and equity mutual

funds are the same size as they were five years ago. The checkered history of financial investments

in Russia, inflation and the recent financial crisis have clearly taken their toll, and we believe it will

take some time before the sector is able to grow rapidly.

Russian mutual funds AUM, $ mln

0

5,000

10,000

15,000

20,000

25,000

2005 2006 2007 2008 2009 2010

equity real estate bonds balanced other


Polish mutual funds, % of GDP

0%

2%

4%

6%

8%

10%

12%

1995 1997 1999 2001 2003 2005 2007 2009

Source: Polish Central Bank

INSURANCE SECTOR

Conditions in the insurance sector remain uncertain, so we believe that growth will be limited to no

more than 10%. This would imply an annual increase in total funds of only around $1 bln.




14 TROIKA DIALOG

Liabilities

SUMMARY

As we have seen, Russia has but a small number of liabilities outside the corporate sector. The

financial sector is pretty much just a passthough for local deposits at present. We believe that the

government and household sectors should be able to increase their liabilities, but that the corporate

sector will struggle to take on large amounts of additional foreign debt, as leverage is already

relatively high.

Liabilities/GDP

0%

30%

60%

90%

120%

150%

Government Corporate Financial sector Household

US Russia

Source: US Federal Reserve, Central Bank, Cbonds




TROIKA DIALOG 15

Capital Markets

Summary

If we look at the four big markets of traded equity, corporate bonds, bank bonds and government

debt, they are all small in Russia as a percentage of GDP.

Traded markets, % of GDP

0%

20%

40%

60%

80%

100%

120%

Traded domestic

equity

Government

debt

Corporate

bonds

Bank bonds

US Russia

Source: US Federal Reserve, Cbonds, Bloomberg, Troika estimates

Equity market

HOW BIG IS IT?

The equity market is quite large in the global context, with a market cap of some 70% of GDP.

Market cap/GDP

0%

30%

60%

90%

120%

150%

China Russia Brazil US India

Source: Bloomberg

WHO OWNS WHAT?

We have detailed bottomup estimates from our analyst teams on the ownership of most of the

market. From these, we are able to estimate that the government owns 29%, oligarchs and

management another 29%, foreigners and other companies some 12%, and the free float is 30%.

Given that we will not be aware of all closely held stakes, the real free float is likely to be lower than

this, perhaps closer to 2025%, or around $250 bln.




16 TROIKA DIALOG

Equity market ownership

30%

29%

15%

14%

6%6%

Free float

GovernmentOligarch

Management

Other company

Foreigners

Source: Companies, Troika estimates

We believe that this is a relatively low free float, compared with other markets, and that a relatively

high proportion of the market is held by the government and oligarchs.

WHO OWNS FREE FLOAT?

We are able to determine with a reasonable degree of accuracy the ownership of over half the free

float. We know from public filings via Lionshares that foreign institutional shareholders own $120 bln,

we know from Russia’s Central Bank that Russian banks own $19 bln, from investfunds.ru that

Russian mutual funds own $4 bln, and from the insurance regulator that insurance companies have

$2 bln of stock. We assume a maximum of 40% of private pension assets ($10 bln) in the equity

market, and around 10% of the market, or $25 bln, held by retail investors.

The remaining $68 bln (28% of the adjusted free float) we assign to local and international hedge

funds and other organizations whose assets are not fully captured by Lionshares, such as Prosperity

and the various hedge funds of London or New York.

Ownership of equity free float

0%

10%

20%

30%

40%

50%

F o r e i g n

l o

n g o n l y

H e d g e

f u n d s

R e t a i l

B a n k s

P e n s i o n

f u n d s

M u t u a l

f u n d s

I n

s u r a n c e

f u n d s

Source: Central Bank, Lionshares, Troika estimates

Within the foreign longonly funds, data from Lionshares are able to identify the largest holders of

stocks as below. The largest foreign fund, JPMorgan, has twice as much capital in the equity market

in Russia as the entire Russian equity mutual fund sector.




TROIKA DIALOG 17

Foreign equity investors in Russia, $ mln

0

2000

4000

6000

8000

10000

J P M o r g a n

A s s e t

M a n a g e m e n t

V a n g u a r d

G r o u p , I n c .

N o r g e s B a n k

I n v e s t m e n t

M a n a g e m e n t

V a n E c k

G l o b a l

B l a c k R o c k

F u n d

A d v i s o r s

B a r i n g A s s e t

M a n a g e m e n t

L t d . ( U K )

B l a c k r o c k

I n v e s t m e n t

M a n a g e m e n t

S w e d b a n k

R o b u r F o n d e r

A B

T e m p l e t o n

A s s e t

M a n a g e m e n t

A P G A s s e t

M a n a g e m e n t

E a s t C a p i t a l

A s s e t

M a n a g e m e n t

D W S

I n v e s t m e n t

G m b H

Source: Lionshares

Russian mutual fund managers are relatively small in comparison.

Russian mutual funds, $ mln

0

100

200

300

400

500

600

T r o i k a

D i a l o g

U r a l S i b

A l f a

C a p i t a l

R a

i f f e i s e n

C

a p i t a l

D e u t s c

h e U F G

B

a n k o f

M

o s c o w

A t o n

M a n a g e m e n t

T

K B B N P

P a r i b a s

K a p i t a l

G a z p r o

m b a n k


BENCHMARKING TO US

While the data from the US is excellent, it does not give the amount of equity owned by the

government or other corporates. Benchmarking to Russia thus becomes a little difficult, but we can

still give a sense of how the two compare.

Equity market size and owners, % of GDP

0%

30%

60%

90%

120%

150%

T o t a l

T o t a l t r a d e d

s t o c k s

H o u s e h o l d s

M u t u a l

f u n d s

P e n s i o n s

F o r e i g n e r s

L i f e

i n s u r a n c e

O l i g a r c h s /

c o r p o r a t e s

S t a t e

US Russia

Source: US Federal Reserve, Central Bank, Troika estimates




18 TROIKA DIALOG

What is notable about Russia is that the total traded sector as a percent of GDP is low and the

amount of institutional money is also low, but the amount owned by the state and by oligarchs and

corporates is relatively high.

WHAT DO THEY OWN?

The contrast between what foreign investors own and what is owned by retail investors is very

instructive. Local investors tend to be much more heavily weighted to reform stories such as utilities

(MRSK Holding, OGK2, MRSK Urals and RusHydro) and Rostelecom. And foreign investors are

more heavily weighted to growth stories such as Sberbank, MTS, Magnit and NOVATEK.

Split of foreign holdings

0%

4%

8%

12%

16%

G a z p r o m

S b e r b a n k

L U K o i l

M T S

M a g n i t

N o r i l s k N i c k e l

N O V A T E K

R o s n e f t

K a z a k h m y s

V i m p e l C o m L t d

P e t r o p a v l o v s k

M e c h e l

S u r g u t n e f t e g a z

X 5 R e t a i l

G r o u p

S i s t e m a

Source: Lionshares

Split of local holdings

0%

3%

6%

9%

12%

15%

G a z p r o m

V i m p e l C o m L t d


S b e r b a n k

L U K o i l

R o s n e f t

R u s H y d r o

M R S K H o l d i n g

S b e r b a n k p r e f

R o s t e l e c o m

O G K 2

S u r g u t n e f t e g a z

p r e f

M T S

V T B

T r a n s n e f t p r e f

Source: Troika data for retail portfolios

WHY IS TRADING SO HIGH?

One anomalous aspect of the Russian equity market is that trading is so remarkably high (over

$5 bln a day) given the lack of domestic money. We believe the answer to this, as we argued in our

report on the issue, is that domestic investors trade with alarming frequency. We calculated, for

example, that the free float of Sberbank turns over nearly once a week.

Government bond market

HOW BIG IS IT?

As is well known, the Russian government bond market is rather small. The total size of government

debt is $64 bln in ruble bonds and $25 bln in Eurobonds. This is tiny compared with the mighty debt

of the US, where the Treasury bond market is $8.6 trln and the municipal bond market is $2.8 trln.

Traded government debt/GDP

0%

20%

40%

60%

80%

Russia US

Ru ss ia domestic Ru ss ia int l US feder al US stat e

Source: US Federal Reserve, Cbonds




TROIKA DIALOG 19

WHO OWNS IT?

The majority of the Russian government ruble bond market is owned by local investors; we estimate that

banks own over half, and pension funds around a quarter. Very little is owned directly by individuals.

We estimate that almost all of the syndicated debt is owned by foreigners, as well as some 70% ofthe foreigntraded debt.

Ownership of Russian government bond market

0%

20%

40%

60%

80%

100%

Ruble debt Dollar debt

Locals For eigners

Source: Troika estimates

Corporate bond market

HOW BIG IS IT?

Russian corporates have $58 bln in listed ruble debt and $60 bln in listed forex debt. This is small in the

context of the $4.3 trln US corporate bond market and the corporate mortgage market of a similar size.

Corporate bonds, % of GDP

0%

10%

20%

30%

40%

50%

60%

Russia US

Russia: ruble Russia: $ US corporate bond US corporate mortgage

Source: US Federal Reserve, Cbonds

WHO OWNS IT?

In a similar manner to the government bond market, we believe the majority of the local corporate

bond market is owned by local investors (61% by banks) and the majority of the Eurobond market

is owned by foreigners.

Bank bond market

Russian banks have $28 bln in ruble bonds outstanding and $45 bln in Eurobonds, a total of 5% ofGDP. This is small in the context of the 38% of US GDP in bank bonds.




20 TROIKA DIALOG

Capital Raising Plans

What is planned?

SUMMARY

We estimate that the government and Russian companies would like to raise over $90 bln a year for

the next few years via borrowings, privatizations and capital raisings.

Net capital raising in Russia, $ bln

0

50

100

150

200

250

2005 2006 2007 2008 2009 2010 2011 2012 2013

Local debt Foreign debt Total equity

Source: Cbonds, Central Bank, Dealogic, Troika estimates

This level of capital raising is not dramatically more than has been raised in the past, though it is

likely to prove more difficult, as foreign capital is not as readily available as before.

PRIVATIZATIONS

The government plans up to $60 bln in privatizations over the next three or so years, as detailed in

our 2011 strategy.

IPOS

In our 2011 strategy we identified over $20 bln of IPOs planned, although it should be pointed out

that there is usually a significant gap between the plan and what materializes.

GOVERNMENT BORROWING

The government plans to borrow around $20 bln annually, mainly in the bond markets. While theplan is to raise this money mostly in ruble bonds, we assume that the government will need to tap

the Eurobond market in order to avoid crowding out the domestic market excessively.

CORPORATE BORROWING

We believe that each year corporations will seek to borrow around $20 bln net in rubles and a

further $20 bln in forex.

How feasible are these plans?

EQUITY

A total of $30 bln of equity capital raising does not sound like much in the context of a market that

is around $1.0 trln in size. However, it is large in the context of the history of the Russian market,




TROIKA DIALOG 21

given that real free float is not much more than $200 bln, the total raised in the past has never

reached $40 bln and, in the context of other BRIC markets.

Equity capital raising in BRIC, $ bln

0

40

80

120

160

2007 2008 2009 2010

China Brazil India Russia

Source: Dealogic

LOCAL DEBT

Net issuance of a little over $30 bln is quite large in the context of a domestic market that has never

raised more than $30 bln.

FOREIGN DEBT

Net issuance of $25 bln is feasible in the context of past borrowing by Russia from abroad, although

we are concerned by the relatively high indebtedness of the corporate sector.

Russia as a financial center

As we have noted in previous research, a commission under Alexander Voloshin is currently seekingto encourage the emergence of a financial center in Moscow. However, we believe that this will be

difficult until Russia is able to put into place a number of measures to encourage foreign

participation and the formation of longterm domestic capital in debt or equity. From our

perspective, key issues include the following.

█ The solution to the various technical issues preventing foreign institutional money from investing in

the country. At present, for example, Capital Research, one of the world’s largest managers of

emerging market money, recently noted that only 30% of their funds under management are able

to be invested in Russia. The point at issue is that certain technical standards (mainly centered on the

depository system) that are required by US regulation (the SEC’s Reg 17F7) are not met in Russia.

█ The improvement of corporate governance so that minority shareholders receive the same rightsas others. This will take not merely legislation, but also significant action by the government to

correct some of the more highprofile abuses.

█ The formation of longterm domestic money through capital deepening. As we have seen above,

capital exists in the banking sector as deposits; the issue is to persuade investors to extend its

duration and to enter the financial markets. Moves that would encourage this (apart from time and

financial stability, of course) are lower inflation and legislation to improve the pension system.




22 TROIKA DIALOG

Appendix 1: How Russia’s PensionSystem Works

There are three main parts to the Russian pension system, as encapsulated in the (slightly

simplified) chart below, where the boxes represent assets and the lines represent flows in 2010.

The main part is a payasyougo system, and this has been supplemented in recent years by

some state and private asset accumulation, although these are still relatively small. The total

pension assets under management are $48 bln, or 3% of GDP, compared with current annual

expenditures in the payasyougo system of $152 bln, or 10% of GDP.

Russia’s pension system

Employers

PFR

VEB pension

fund, $24 bln

Pensioners

NPF,

$20 bln

Mandatory

pension

insurance

Mandatory

accumulative

pension

Employer

sponsored

pensions

Federal budget

NPF,

$4 bln

$12 bln

$152 bln

$93 bln

6% payroll for

born after 1967

$13bln

20% payroll

$72 bln

NPF,

$4 bln

$1 bln $2 bln

$152 bln 0 $1 bln0

Discretionary

$ 2 bln

Note: Arrows represent annual money flows. All flow amounts are estimated for 2010.Numbers in the boxes represent assets accumulated by the entities.

Source: State Pension Fund, Investfunds.ru, Troika estimates

The payasyougo system

How it works

The main foundation of the Russian pension system is a payasyougo system. Each year

employers make mandatory payments of 20% of salary (up to a $14,000 salary cap) into a

government fund. In 2010, this will raise $59 bln. The government then adds $93 bln to this, and

pays out $152 bln directly to pensioners.

Clearly, then, in this system there is no saving or room for the accumulation of longterm money.

History

The increase in pension payouts has been enormous, rising from 6% of GDP in 2007 to 10% today.

Only recently has the state needed to fund it to such a degree, with the pension deficit rising from

$24 bln in 2007 to $80 bln in 2010.




TROIKA DIALOG 23

Income and expenditure for the payasyougo pensionsystem, $ bln

0

50

100

150

200

2007 2008 2009 2010E 2011E

Raised by taxes Total payout


Global context

The payasyougo system will pay out $152 bln in 2010, or 10% of Russian GDP, which is high inthe international context.

Pension payments, % of GDP

0%

4%

8%

12%

16%

Canada US UK Spain Russia Germany Italy

Source: Peterson Institute

Future plans

In 2011, the mandatory payment by employers will rise to 26% of capped salary, meaning that the

pension taxes should raise just under $100 bln.

Meanwhile, the total pension payment is scheduled to rise 9% in ruble terms to around $159 bln in

2011. The gap will again be made up by the government.

Savings part: government linkedHow it works

For those who were born after 1967, 6% of the payroll goes to individual accumulation accounts,

where the plan is that they will be used after 2020.

An individual may choose where to put this money, with the choice to select either one of the 164

nongovernment pension funds or the state asset management company controlled by VEB. If a

person makes no choice, the money is left with VEB. As with most systems like this, most people

choose the default option, and VEB ends up with most of the money.

History

The VEB funds have accumulated $24 bln, while the nongovernment pension funds have $4 bln.




24 TROIKA DIALOG

Annual flows

The flow to these funds is $13 bln a year at present, a l ittle under 1% of GDP.

Where is this money?

We believe that the VEB funds are all in government bonds, as are at least 60% of funds held by the

nongovernment sector.

Future plans

At present, the government has proposed that this accumulation system be shut down and

resources are diverted into the payment of current expenditures. However, a final decision on this

has yet to be made.

Savings part: private

How it works

There are two aspects to private pension funding in Russia.█ Employers may sponsor their own plans.

█ Employees may pay money into their own funds directly. An employee can pay up to R12,000

($400) a year, which is matched by the government up to the same amount. One slightly confusing

aspect is that this money actually goes into the same system as the governmentmandated savings,

although this is merely a technical issue that need not concern investors.

Annual flows

Annual flows at present are around $2 bln from employers, and we believe that they are very low

from employees.

How much is there?

The large Russian employersponsored funds have $20 bln of money. The employee funds are still

very small.

Who runs this?

The Gazprom pension fund is by far the largest, controlling 46% of the sector.

Sponsors of Russian employer pension funds

0

2

4

6

8

10

G a z p r o m

R u s s i a n

R a i l w a y s

T r a n s n e f t

K h a n t y M a n s i i s k

R e g i o n

U E S

L U K o i l

S v y a z i n v e s t ,

R o s t e l e c o m

R o s n e f t


T a t n e f t

O t h e r


Where is it invested?

We estimate that perhaps 40% of this money is invested in equities.




TROIKA DIALOG 25

Appendix 2: Russian Capital Flows

We present below the summarized current and capital account of Russia since the start of reforms.

Money flows in Russia, 19942010, $ bln

E

x p o r t s

I m p o r t s

I n c o m e s r e

c e i v e d

I n c o m e s p a i d

F D I i n

R u s s i a

O t h e r i n v e s t m

e n t i n

R u s s i a

F D I a b r o a d

C a p i t a l o u t f l o

w

a n d

o t h e r i n v e s t m e n t s

a b r o a d

F o r e x r e

s e r v e s

a c c u m u l a t i o n

0

500

1,000

1,500

2,000

2,500

3,000

3,500


It is possible to simplify these flows to just three main drivers: the current account, foreign

borrowing, and capital flight; the balance of these three is foreign reserves accumulation. While

capital outflow has been a constant backdrop, it was overwhelmed by the current account surplus

and foreign borrowing from 2006 to mid2008. Thus, foreign capital seemed so easy to attract

during the boom years.

However, looking forward, we expect the current account to shrink markedly, and we expect

foreign borrowing to be much constrained. This is likely to reduce the flow of “easy” foreign capital

into the country, and make Russia more dependent on capital markets.

Quarterly capital flows, $ bln

150

100

50

0

50

100

1 9 9 4

1 9 9 5

1 9 9 6

1 9 9 7

1 9 9 8

1 9 9 9

2 0 0 0

2 0 0 1

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

Current account Foreign borrowing Capital outflow





26 TROIKA DIALOG

Analyst certification

The following analyst(s) hereby certify that the views expressed in this research report accurately

reflect such research analyst's personal views about the subject securities and issuers and that no

part of his or her compensation was, is, or will be directly or indirectly related to the specific

recommendations or views contained in the research report: Andrey Kuznetsov, Kingsmill Bond.



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